Mega-Deduct and Convert: Save Thousands On Roth IRA Contributions

Mega-Deduct and Convert: Save Thousands On Roth IRA Contributions

This article from the Finance Buff explains a great way to save hundreds on Roth IRA contributions.

But I wanted to expand upon this idea and highlight an even bigger way to save using a similar strategy. Thanks to changes in tax law, the “deduct and convert” strategy has become much more beneficial. Before you read on, if you’re pre-retirement age, you must reside in Illinois or Kentucky for it to work well. For all Kentucky and Illinois residents, pay close attention!

The Original Strategy

This strategy exists thanks to Kentucky and Illinois favorable IRA rules. Both states allow state income tax deductions on IRA distributions (including Roth conversions) up to state specific limits. They also allow state income tax deductions on qualified Traditional IRA contributions.

The strategy involves contributing to a traditional IRA, taking the tax deduction (assuming you qualify), and then converting it to a Roth IRA. Kentucky has a progressive state income tax which ranges from 2% to 6%. Most people are paying closer to the top.

For example, in Kentucky if you contribute to an IRA and qualify for the deduction, you’re able to deduct the contribution for state income taxes. So no state income tax going in. You’re also able to convert Traditional IRA’s to Roth (aka Roth conversion) at any age and avoid Kentucky income tax on the converted amount. So no state income tax on a conversion to a Roth IRA.

By taking the extra step, you avoid state income tax on the Roth IRA contribution. For someone in the top KY tax bracket, this strategy effectively saves them 6% on the contribution amount when compared to contributing directly to a Roth IRA. For a $5,500 contribution, that’s $330 in tax savings. With two IRA’s maxed out at $11,000, the max household benefit would be $660.

Although $660 is better than a poke in the eye, it may not be worth the hassle to many taxpayers. And most don’t even qualify in the first place because they don’t live in Kentucky or Illinois and/or cannot deduct IRA’s. We’re talking about a small benefit for a small group.

However, since the article was written, new laws now allow 401k’s to offer in-plan Roth conversion. This effectively opens up the strategy to 401k participants and raises the stakes with much higher contribution limits!

Mega-Deduct And Convert

Greg and Jane live in Kentucky and plan to maximize Roth 401k’s in 2017 ($18,000 each) for a total household contribution $36,000. Instead, they contribute $36,000 to traditional pre-tax 401k’s and in the same tax year convert $36,000 to a Roth 401k. The Traditional 401k contribution is pre-federal and state income tax. The Roth conversion causes additional federal income tax but avoids state income tax. Basically, the federal income tax offsets and ends up the same as if they had contributed directly to Roth. However, they save 6% in state income tax by taking the extra step thanks to the favorable Kentucky IRA tax laws. This saves them $2,160 of state income tax. Now we’re talking about a pretty serious benefit.

The net effect for Kentuckians is a 6% boost on Roth 401k contributions (3% for Illinois). This works especially well for those already planning to contribute to Roth 401k. However in reality, most people aren’t 100% certain that the Roth is better than simply going with the traditional 401k. There are several additional factors to consider as detailed in this article by Michael Kitces on making the Roth vs Traditional decisions. Also, there is also the fact that state income taxes are potentially deductible if you itemize deductions. If this is the case, the effect of this benefit will be reduced based on the tax savings of the deduction.

There’s also the step transaction doctrine to consider. This IRS catch-all rule says you cannot take multiple steps to circumvent the rules. This might be viewed as a violation under audit. Therefore, because of this and because in reality most people aren’t sure if the Roth is actually best (even with potential for up to 6% boost), an even better strategy would be to go ahead and contribute to the traditional 401k. Wait and see how the year shakes out. And decide on the Roth Conversion at the end of the year. Doing this actually gives you a much better idea of what your marginal tax bracket will be which factors heavily into the decision. This allows you to make the decision based on the maximum amount of information. It also lessens the chance of it being considered a violation of the step transaction doctrine.

As with any potentially taxable transaction, you should ultimately consult your tax advisor before moving forward.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

PSLF Lawsuits and Why You Can’t Rely On Servicers for Good Student Loan Advice

PSLF Lawsuits and Why You Can’t Rely On Servicers for Good Student Loan Advice

October of 2017 will mark the first year for borrowers to become eligible for loan cancellation through the Public Service Loan Forgiveness (PSLF) program. This program promises tax-free forgiveness to borrowers who make 120 qualifying payments while working for certain employers — generally either for the government or a non-profit organization. Unfortunately, it is becoming clear that the number of those expecting forgiveness is much greater than those who will actually see their loans cancelled later this year.

As borrowers begin to apply for forgiveness, many are finding that they were never eligible, despite previously being approved by their loan servicers. Given the way various payment plans are structured, this means that many people will have a higher balance today than when they entered into repayment, with no relief in sight. As a result, many are filing suit against the Department of Education, as well as servicers like Navient who previously informed borrowers that they were approved. If their claims are accurate, this would understandably create some concern from those counting on their loans being forgiven.

Despite what many are considering a broken promise by the DoE, it appears as though those at the heart of the lawsuit weren’t ever eligible for forgiveness. In order to be eligible for PSLF, you must follow these three criteria:

  • Eligible Loans – Specifically, FFEL loans are not eligible
  • Eligible Repayment Plan – IBR, RePAYE, or PAYE are the most common. Graduated, or extended plans, while sometimes resembling income driven repayment plans, do not qualify.
  • Eligible Employer – generally a government or 501(c)(3) organization.

The biggest source of confusion seems to be the eligible employer criteria, as the tax-exempt status of many organizations can be confusing. In fact, the American Bar Association — which is one of the employers in question in the suit — is considered a 501(c), which can be confusing to even the most savvy of borrowers. If you are unsure of the tax exempt status of your employer, you can look it up online.

While being sure up-front about your eligibility for forgiveness is ideal, this situation also could have been prevented if the servicers hadn’t initially “approved” these borrowers. The key takeaway here is that the loan servicers do not work for the borrower – they work for the lender. As a result, they are not a viable option for seeking counsel on your loans. In fact, it may be the opposite, per Navient executive Jack Remondi — “There is no expectation that the servicer will act in the best interest of the consumer.

It is important to be fully aware of your options, as well as being confident that the one you have selected is best for you and your repayment strategy. If not done properly, it can cost you big time. And with many graduating medical students holding loans in excess of $300,000, it pays to be proactive.

If you have questions or would like to discuss your student loans, you can schedule a free consultation with us here. You might also find some valuable information in our Complete Guide to Student Loans.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

Student Loan Perks Designed to Recruit Physicians Can Actually Hurt Them

Student Loan Perks Designed to Recruit Physicians Can Actually Hurt Them

Many physicians entering practice today owe more than $200,000 on their federal student loans. It’s become a major priority to address these massive loans as they enter into practice.

As a result, hospitals are introducing physician loan repayment perks for new hires to drive recruitment. However, confusing intricacies with the new Public Service Loan Forgiveness program “PSLF” are causing major unintended consequences.

Here’s how the typical physician loan repayment perk goes:

Dr. Smith is finishing training and owes $400,000 on his student loans. He signs on with a hospital for three years of employment and, in exchange, the hospital will pay $75,000 toward his student loan balance. The hospital pays the $75,000 directly to the loan servicer in one, lump-sum payment (or sometimes spread out over three annual payments). If Dr. Smith breaks his contract early, he must repay some or all of the stipend.

At first glance, it’s a win win. The hospital wins by getting Dr. Smith to sign on. Dr. Smith wins by receiving help with his massive student loans.

PSLF Game-Changer

Public Service Loan Forgiveness “PSLF” totally changes the game. Physicians who have qualified loans and are employed (full-time) by a qualified employer and make 120 qualified payments can receive tax-free forgiveness of any remaining balance (after they successfully prove everything was “qualified”).

Qualified loans are federal direct student loans – these are by far the most common type of student loans young physicians take out for medical school. If they happen to be federal non-direct, there are methods to change them into direct to make them “qualified”.

Government, 501(c)3, AmeriCorps, Peace Corps and other qualifying public service employers are considered qualified employers. The majority of hospitals (and residency programs) in the US fall into this category.

A qualified payment is a successful payment made to any qualified loan under any of the income-driven repayment plans or the 10 year standard repayment plan while employed by a qualified employer. These income-driven payments are exactly what they sound like – payments set based on income. Lower income equals lower payments and under most plans, there is a payment cap.

Maneuvering PSLF

Any medical resident with any wherewithal will rack up low PSLF qualifying payments and set themselves up to receive massive PSLF benefits if they end up with a qualified employer. The value builds during residency and remains even if the new physician scores an extremely high-paying job. It’s not uncommon for us to see physicians making mid six-figure salaries on track to receive tax-free six-figure PSLF forgiveness.

PSLF makes student loans unlike any normal debt. With normal debts, the more you pay, the less you end up paying back. Extra payments to principal are great because you save interest. With PSLF, the less you pay, the less you end up paying back. All payments are equal for PSLF therefore, lower payments are always better for the borrower. The $0/mo qualifying payment has the same PSLF value as a $3,000/mo qualifying payment. Once you rack up 120 qualified payments, all remaining qualifying debt vanishes tax-free. The physician that ends up paying the lowest possible total 120 qualifying payments will maximize PSLF value. In most cases, additional payments to principal are worthless. Seems odd right? If you don’t believe me, check out the rules here.

Student Loan Perks for New Doctors

As 501(c)3 hospitals implement student loan repayment perks, they fail to consider the PSLF benefit. In the earlier example, Dr. Smith also happens to be on track for PSLF. In fact, he signed on with this hospital partly because they were a 501c3 so that he could continue qualifying for the program. He’s already satisfied 60 PSLF qualifying payments during residency and fellowship. Therefore, all he needs is 60 more payments to receive full forgiveness. Dr. Smith isn’t sure how the $75,000 will affect PSLF however he assumes it can’t hurt. As strange as it might seem, the $75,000 paid toward his student loans has no affect on PSLF except that it’s taxable income and therefore increases his total remaining payments by $7,500. It turns out he would have been better off receiving nothing. On top of this, Dr. Smith has to pay tax on the $75,000. IF we assume the tax is 40%, that’s $30,000.

In this case, Dr. Smith would have benefited $37,500 by declining the student loan perk. The hospital would have also saved $75,000. That’s $112,500 of missed opportunity.

PSLF Friendly Student Loan Perks

One solution would be for 501c3 hospitals to stop paying student loan stipends directly to servicers. Instead they could pay the borrower directly. However this would not incentivize physicians to maximize PSLF and it wouldn’t save the hospital any money.

To accomplish the desired outcome, 501(c)3 and government hospitals must restructure their student loan recruitment perks to consider PSLF. Because of it’s surprising complexity, it’s rare to see physicians maximizing the program.

A better solution would be for hospitals to use a small portion of their “student loan perk” funds to hire student loan consultants for their new physicians to help them navigate and maximize PSLF. Hospitals could then reimburse the physician for successful PSLF payments made. This would incentivize physicians to manage PSLF effectively and lower the hospital’s loan reimbursement payments. This would save the hospital money and help physicians eliminate their student loan burden faster.

PSLF has changed the game and hospitals must adapt if they want to attract and retain top physician talent. It’s only a matter of time before hospitals figure this stuff out and start offering new and improved recruitment incentives that help address the student loan problem. In the mean time, if you have a similar offer, it’s worth having a conversation with your employer about an alternative set-up that could ultimately save you thousands.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

WFP’s Recommended Reads: December 2016

WFP’s Recommended Reads: December 2016

At the end of each month, we provide a list of finance-related articles to help keep you informed about the hot topics in finance. Here are some of the best articles we read in the month of December.

IRAs, RMDs, and the Crisis of Doctors with Too Much Money In Retirement(White Coat Investor).
Phil Demuth, PhD, explores the very real problem for physicians of having too much income in retirement as well as tax-planning strategies for how to most effectively prepare for it.

Ten News Stories that Offer Financial Lessons(Washington Post)
Everything from Prince’s death to the upcoming fiduciary rule. How ten of 2016’s biggest news stories taught us some very important lessons in finance.

20 Rules of Personal Finance(A Wealth of Common Sense)
A great list of rules to always keep in mind regarding your own personal finances. Everything from understanding the difference between salary and savings, to handling major purchases.

Diversification is No Fun(A Wealth of Common Sense)
The cyclical nature of the financial markets is perhaps their single most reliable aspect. For this reason, a truly diversified portfolio will always perform “worse” than the current cycles’ best performing asset class. It is important not to chase after the big performers, as these cycles will inevitably reverse.

Is Early Retirement Great? For Some, It’s Hard Work To Have Fun(New York Times)
Far too many people are counting down the days until they can retire from their careers. This article addresses the importance of life after retirement, and how it’s perhaps more important to retire to something, not just from something.

Tips for Understanding How Doctors Are Paid(Medical Economics)
Great read for doctors new to their careers, or unfamiliar with how exactly they are compensated. This article dives into the structure of compensation agreements and RVU’s and how to best inform yourself so that you can avoid making any costly mistakes with your next practice.

All Indexes Are Not Created Equal(Irrelevant Investor)
How is it that some indexes outperform others within the same asset class? Despite tracking similar indexes, not all funds maintain the same weighting across sectors. It is important to understand that one year’s performance in similar funds does not provide sufficient evidence as to which is superior. As with any investment, we should evaluate based on long-term performance.

What History Tells Us About Your Investments in 2017(Washington Post)
As we move into 2017, there are many prevailing narratives for what to expect in the coming year. This article provides some historical perspective for what we can expect as we enter the year under a new president, as well as a period of rising interest rates, among others.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

5 Questions Every Physician Must Ask Their Financial Adviser

5 Questions Every Physician Must Ask Their Financial Adviser

Recently, we were featured in the Medical Economics magazine. The first few items on our list of “5 Questions Every Physician Must Ask Their Financial Adviser” are below, and you can find the rest of the list here (page 30).

1) Are you a Fiduciary 100% of the time?

Unlike most professionals, financial advisers have a choice of operating under one of two professional standards: suitability or fiduciary. The fiduciary standard requires advisers to act in their client’s best interests, whereas the suitability standard does not.

Advisers fall into one of three camps: fiduciary all the time, suitability all the time or both. Those that do both “wear two hats” by switching back and forth between suitability and fiduciary standards. Don’t settle for the part-time fiduciary. It’s best to verify they’re acting as a fiduciary all the time.

2) How Many Physicians Do You Work With?

Cutting-edge advisory firms are building niches to stay relevant and provide the best possible value to their clients. Industry experts say firms should target between 50 and 150 clients per adviser depending upon the level of services provided.

If they’re dedicated to a specific niche, at least 50% of those clients should be within it. The more specific their niche, the better. Ideally your adviser has a manageable number of clients with a very high percentage consisting of physicians just like you.

You can continue reading here!

Reducing the Noise: Making Better Investment Decisions

Reducing the Noise: Making Better Investment Decisions

When it comes to investing, perhaps the single most common thing we see that trips up our clients is the temptation to act on the chatter around them. Whether it be a close friend, newspaper article, or financial pundit on TV, there is no shortage of people offering their opinions on how they believe a particular stock, or the market in general, can be expected to behave.

“A big named-brand company secures a lucrative deal. Buy.”

“Unrest in the Middle East. Sell.”

“Gas Prices at an all-time high. Sell.”

“The world is afraid of a Donald Trump Presidency. SELL!!”

The disappointing thing to us is that people actually act on these recommendations! Clients are always looking for ways to either earn a premium, or more frequently, avoid loss of principal. And for that reason, comments like these that are broadcast on CNBC or published in the Wall Street Journal have tremendous impact on those who are exposed to it. It truly never ends; yet, for every person that gets it right, there are a dozen more that swing and miss….badly.

Even the financial experts at Goldman Sachs are guilty. From August 2nd: “Goldman Sachs Says Stay Away From Stocks for the Next Three Months”. The S&P is up 5% since this was published. Can you imagine what the people who followed this commentary must be thinking? That is a lot of money left on table.

Why is this so easy to fall prey to?

There are a number of reasons why we find ourselves getting excited over the constant noise infiltrating our lives. While it is often impossible to resist, the most important step to eliminating rash behavior is to understand why it occurs in the first place.

One of the primary factors that explain how otherwise very smart people can find themselves moving to cash simply from the commentary of a Goldman Sachs analyst is what is referred to as narrative bias.

Narrative bias occurs because our mind is trained to attach itself to a plausible narrative. That is, most people will believe a majority of what they are told, simply because it makes sense to them. People don’t believe that the stock market is headed for impending doom without a believable story to go with it.

The most dangerous market noise to you personally, is that which comes with a story that you are most likely to believe. Donald Trump opponents are far more at risk for falling for the “Donald Trump is going to lead to a recession” narrative. And Risk Averse people are overly-susceptible to acting on the “Goldman Sachs says to sell all stocks” narrative.

Understanding where you may be vulnerable can help you prevent yourself from making real mistakes.

But what impact do these seemingly important events actually have in the stock market?

The answer is not much. We must be careful not to reduce our understanding of the stock market to one single event. In reality, the market acts in response to hundreds, or even thousands of events simultaneously. Trying to explain or predict it’s behavior as a result of one, or even a few factors, is setting yourself up for investment failure.

Instead, we should acknowledge our limitations. We don’t know what will happen to the price of a stock simply because a company announces the release of a new product. And as a result, we shouldn’t base our buy and sell decisions on such. Take a disciplined, long-term approach to managing your portfolio. Be mindful of the narratives — you will hear them daily. Instead of reacting and making potentially costly decisions, make a deliberate effort to stay disciplined. You won’t regret it.

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© Wrenne Financial Planning | Crafted by Harris & Ward

Wrenne Financial Planning LLC (“WFP”) is a registered investment adviser offering advisory services in the State of KY, TX, TN and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of WFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.